The Six Strategies for Creative Financing Deals Part 1
Creative financing is simply structuring seller-financing deals with little to no money down without using traditional bank financing. A lack of knowledge and practical application of creative financing prevents a lot of would-be investors from entering the game of real estate investing.
Even if you’re a seasoned investor, are you missing out on deals due to a lack of creativity on your part? In a previous article I discuss my 2-step process for making offers using seller financing (go here to read it now).
In this article I want to discuss 3 of the 6 different creative financing strategies. Note: When I use the word “mortgage” this could be interchanged for “trust deed” since some states use a mortgage and some states use a trust deed.
Watch this video if you don’t know the difference between a Mortgage and a Promissory Note:
Let’s get started...
#1. Create a Junior Mortgage
This strategy works best when a bank is willing to lend the majority of the purchase price and a seller is willing to wait for the balance.
Let me explain using an example:
- Let’s say the purchase price is $100,000 and a lender will do a loan for 80% of $80,000 but you don’t have the other 20% or $20,000.
- So the seller is willing to create a second or junior mortgage for the balance of $20,000.
- Of course, this is assuming the lender will allow a seller second and is only concerned about their loan to value (LTV) and equity position and not worried about the borrower being over-leverage and not putting any cash in the deal.
- In this situation, the seller gets the majority of his money for the sale ($80,000). The buyer was able to get into the deal with 100% financing (a first lien for $80,000 and a second lien for $20,000).
- Keep in mind, in a default situation; loans are repaid based on lien priority.
- So in this example, if the borrower defaulted on the loan and it foreclosed for $90,000, the bank would get the first $80,000 (1st lien holder) and the seller (2nd lien holder) would only get the remaining $10,000 and would have lost $10,000 of principal.
That is why junior liens are more risky.
#2. Assumable Mortgage
An assumable mortgage is simply when the buyer takes the seller’s place on the existing mortgage.
There are 2 ways to do this:
- The right way and what everyone does (lol). The right way is to actually change liability on the loan with the bank’s approval,mortgage sign discharging the existing owner of all liability. Of course, the bank would only be willing to do this if the new borrower was stronger then the current borrower otherwise, why would they do it.
- The “other way” a lot of people handle this is to simply take over the payments. The strategy is to stop the bleeding of cash for the motivated seller. Technically this would trigger a “due on sale clause” with the bank, meaning the bank could call the loan due. However, what most have found is that as long as the bank gets their payment each month, they could care less who makes the payment. Just remember, you need tight paperwork in place because the original note holder is ultimately responsible for the loan.
#3. All-Inclusive Mortgage
This is most commonly known as a “wrap” and is another form of secondary financing. It’s similar to the first method explained earlier except rather then paying the seller 80% and creating a new first lien, the buyer assumes the first existing first lien and also creates a 2nd lien that is “wrapped” around the first. Sounds complicated but it’s not.
Let me explain using an example...
- Lets say a buyer and seller agree on a price of $100,000 and the seller currently owes $70,000 to a bank in the first position.
- And let’s say the buyer can’t (or doesn’t want to) qualify for a new loan to pay off the existing loan and they both agree that the buyer will assume the first lien of $70,000.
- In addition, they create a 2nd lien for the balance of $30,000 (just like explained above with a junior mortgage) to get a total purchase of $100,000.
- The downside to the seller is that is has to wait until the buyer flips or re-financed the property before he sees any money from the deal (other than payments on the 2nd lien).
Be sure to watch for Part 2 where I discuss the other 3 strategies for doing creative financing deals with little to no money down and without traditional bank financing… If you found this article helpful and/or informative, share it, like it and leave a comment below.
Until Next time,
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